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Monday, June 13, 2016

Predicting a Crash: Part One

It's the holy grail of bears and the ultimate breath of relief for bulls. It only occurs every once in awhile even though its coveted by economists and analysts across the country. Many claim to have it, but only a few are truly owners. Some might not even realize when it has stumbled upon them. Viewers of the movie The Big Short have seen dramatized representations of some of the best. Stock market crash predictions are definitely hard to come by, but they can save an investor thousands if not millions of dollars while making them seem more intelligent than an entire horde of bumbling day traders that drove stock prices to the ground. This new series, featured on Black Gold Disease, seeks to identify the trends and alerts that will give way to the next "I told you so" moment. In the end, that petty mentality has no room in the words of the next few writings. Instead, this author hopes to dissect the path to the next market crash which he believes is not far on the horizon. Just over seven years ago, the worst financial crisis since the Great Depression plagued the global economy with a major economic downturn that followed in the years that followed. While that event is unforgettable, some might not remember the years of 1936-1937 just about seven years after the crisis in 1929 when markets relapsed into recession after appearing to recover. It is paramount to acknowledge the truth that the economy now is vulnerable to that same weakness. In BGD's Predicting a Crash, I will attempt to find (or fail to find) trends and analysis that tell us when the next crash will come.

Ever since the end of the financial crisis in 2009, equities skyrocketed out of the hole they fell in during a record sized sell-off. The 50-day moving average fell well below its 200-day counterpart but crossed back over in 2011 after two years of a solid rebound. In fact, the optimistic mentality of traders supported an S&P 500 growth rate of 213 percent from the bottom in 2009 to the peak in 2015. A new bull market, defined by an average yearly expansion of 35.4 percent, was ushered in as the Federal Reserve lowered interest rates and the economy recovered. About seven years later, the wide gap between the 50-day average and the 200-day average has begun to shrink and equity movement has entered a trend that appears flat. In addition to the consolidation patterns, two stock market corrections have occurred in the past year both forcing investors to come to terms with the deteriorating global economic condition. Weakness in China, the world's largest source of demand, was almost the sole reason for two minor crashes in late 2015 and early 2016. Despite the sell-offs, equities continued to rebound as sentiment surrounding stocks appeared immovable. While some might wish to ignore it, more risk and fragility are crouching beneath the less volatile environment, and many individuals claim they can see it too.

While just a few commentators will be mentioned, there are thousands of perspectives on the potential of a crisis in 2016. Henry Blodget, on Business Insider, wasn't afraid to highlight the lofty valuations of equities in an article written in January 2016. After looking at many indicators that show expensive (or cheap) stocks are, he concluded that "By many, many historically predictive valuation measures, stocks are overvalued to the tune of 75%-100%." As he explains correctly in the next paragraph, valuations at these levels are often, if not always, subjected to brutal corrections as the asset bubble pops. In the end, he asserts that "the annual returns over the next decade are likely to net out to about 0% per year." In an article by Profit Confidential, the author cites Warren Buffett, John Paulson, and George Soros as the newest bears of the day. These individuals, perhaps the most successful stock traders of our time, have been selling stocks since early 2014 and continue to do so as the pressure builds. If the article's suggestion of "following the smart money" is logical, shouldn't one assume a crash is afoot? Any smart investor knows that only takes a few bears to take down the rickety stock market. In the political arena, two of the largest figures in the Republican party are warning of a looming crash that will come within the year. Ex-Republican presidential candidate Ted Cruz is cited as saying a "crash will be coming," according to CNN Money. His counterpart still in the race, Donald Trump, has also voiced his concern with the market saying it is a "terrible time" to invest and "we're in a bubble right now." Skeptics are everywhere and they tend to point out some of the same things.

Large valuations are only supported by the appropriate fundamentals. But, a look at the balance sheets of companies, households, and governments will reveal little improvement in their personal fundamental position. In fact, most growth has been in the debt category. A report from the McKinsey Global Institute said, "Global debt has grown by $57 trillion and no major economy has decreased its debt-to-GDP ratio since 2007." The chilling realization that liabilities have only increased since the crisis should be scaring investors away from the investing world, but it hasn't. While it isn't often described that way, the global financial crisis in 2008 was a crisis caused by debt, housing debt specifically. The shaded region on the graph indicating the resulting recession in 2009 depicts a flattening of the trend of increasing debt. One would expect the problem to be solved, but the opposite is true. With almost $64 trillion of debt recorded for the last quarter of 2015, the world has failed to learn its lesson, and it might not ever without another crisis. The trend of inflated debt levels forms the basis for by analysis and predictions. The truth is, we cannot eternally increase liabilities because eventually there will be a time for them to be settled. Currently, the global economy is teetering on the edge of these calls, and figuring out what will trigger them is the way forward in predicting a crash.